It’s a common misconception that you need one giant nest egg to supply all of your retirement income.
In reality, most people live off of a combination of income sources when they retire. These sources of income are often called “buckets.” Let’s take an updated look at these different “buckets” and how they might fit into your current or future retirement plan:
Bucket 1: Accounts that have not been taxed yet. One example is the tax deferred portion of a 401(k).
Bucket 2: Accounts that have already been taxed. One example is a Roth IRA.
Bucket 3: Accounts that have a combination of money and investments that have already been taxed and have not yet been taxed. One example is a taxable brokerage account.
Bucket 4: Other sources of income such as social security, pensions, and annuities.
What’s important to consider with these buckets is how and when you’re going to utilize each one to maximize the amount of income for yourself in retirement and wealth for your heirs (if wealth transfer is a concern of yours).
The distribution strategy that you implement is likely going to involve all four buckets, and perhaps different amounts and at different times. This is one of the reasons having good coordination between a tax professional and your Wealth Advisor is so crucial. Timing can be vital here, particularly if your retirement results in a significant and temporary change in income.
Everyone has heard the adage, “it’s not what you earn, it’s what you keep,” referring to after-tax earnings. What you keep in retirement is going to depend on how much money you distribute from each one of these buckets, and when you take those distributions.
Having in-depth conversations with your Wealth Advisor can help you to make informed decisions regarding distribution. Our financial planning software can model out different strategies and get fairly detailed with the potential tax impact. Combine this with information from your tax return, and you can put together a pretty good pro-forma plan for distributing retirement income for yourself, and transferring wealth to heirs, in the most tax-efficient way possible given the current information available. It’s important to remember that laws and personal circumstances change frequently, and plans should be reviewed and updated regularly.
If wealth transfer is a priority for you, determining which assets are most tax efficient to get to heirs during life, and at death, can provide a lot of value. Something as simple as reviewing beneficiaries to make sure each beneficiary is inheriting the most appropriate asset, given your priorities and goals, can go a long way.
Recent changes in the tax law have shifted a lot of the retirement income distribution strategies that were commonplace just a few years ago. For example, the new “10-year rule” that is applicable to many inherited IRA’s subjects beneficiaries to federal income tax much sooner than the prior “stretch IRA” rules that many were expecting to incorporate into their distribution plan. Now is a great time to schedule a meeting with your Wealth Advisor and go through your specific retirement income distribution and wealth transfer strategies.
